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Series I savings bonds have been around longer than the iPhone. They are not as flashy, but I still think they have a nice look to them. They last longer too. If you like paper, they are the only government savings bond still available in that ‘old school’ paper format. Remember the college savings bonds you might have gotten as a kid? I bonds are a lot like those. The only way you can get the paper version these days is with your IRS refund. There are a few hoops to jump through, though.

As you already know, Max likes real-life experiments. So, back in 2019, I set up a little experiment to add a few more paper bonds to my government savings bond portfolio. The net result of the experiment was $1,000 in paper I bonds delivered to my PO Box.

How Does the I Bond Work?

Series I bonds are a government savings bond that earns interest based on combining a fixed rate and an inflation rate. Unfortunately, at the time of writing this, the fixed portion of the bond rate has been reduced back down to 0.0% thanks to the pandemic. The combined composite inflation rate puts the current interest rate at 1.06%. Here is the calculation example directly from the treasury.

For comparison purposes, the $51,436 in cash I am holding in my Vanguard Prime Money Market Fund (VMMXX) is only yielding about 0.39% at the time of writing this.

We are limited to buying $10,000 in I bonds electronically each year. But we can buy an additional $5,000 in paper I bonds each calendar year through our tax return. As I mentioned above, this is the only way to get the paper version of the bond.

I bonds could be a good investment vehicle for the conservative investor or someone who wants to build a safety net for the future. They do require some light planning and understanding of how they work. So, there are few rules surrounding I bonds we should understand. I went ahead and put some of the important ones below that I found interesting. As always, make sure you do your own research and read the fine print.

Interest 

Interest rates are pretty marginal at this point. Let’s face it, locking in at a 0.00% fixed rate is pretty low compared to historical standards. The combined rate is 1.06% through October 2020 when you add in the inflation factor. There is also deflationary protection built into these bonds as outlined below.

There are a few unique things to note on how the interest rate is handled:

• I bonds have an annual interest rate derived from a fixed rate and a semiannual inflation rate derived from CPI-U.
• The fixed-rate remains the same throughout the life of the bond.
• The current rate is 1.06% for bonds issued May 2020 – October 2020.
• Interest-earning period: 30 years or until you cash them, whichever comes first.
• The combined rate will never be less than zero. However, the combined rate can be lower than the fixed rate. If the inflation rate is negative (because we have deflation, not inflation), it can offset some of the fixed rate.

Term

The term of the bond also has some things to consider:

• Minimum term of ownership: 1 year.
• Before 5 years, forfeit interest from the previous 3 months.
• After 5 years, no penalty.
• The interest rate accrues until the bond reaches 30 years (or you cash it).

Taxes

And last, but certainly not least, a few interesting notes on taxes:

• Tax reporting of interest can be deferred until redemption, final maturity, or other taxable disposition.
• Interest earnings are subject to Federal income tax.
• Savings bonds are exempt from taxation by any State or political subdivision of a State, except for estate or inheritance taxes.
• Interest earnings may be excluded from Federal income tax when used to finance education (see education tax exclusions).

Why Paper I Bonds?

As for me, I just wanted paper bonds because I have faith they (and the Unites States Government) will hold their value over time. They also have some flexibility on the tax side of things. I also happen to think they look pretty cool.

In 2019 when I arranged this purchase, the stock market had been on a 10-year run so I figured building in some conservative safeguards never hurts. I was already planning on filling up my $10,000 electronic limit in 2019, so this gave me the ability to go beyond that limit.

Then there’s this – someday I may need to teach interest rate concepts to my children, and they will definitely need visual aids.

I actually remember saving up $37.50 when I was a kid to purchase a $75.00 series E bond. When I got the physical bond, it showed $75.00. I asked my Mom and Dad almost every day how much it was worth until I was told (sternly) to stop asking. It was put away in a plastic holder next to my X-Men cards for safekeeping. I still have it and I believe it is netting 4% per year until 2026.

Getting the I Bonds

When I bought my bonds back in 2019, I had to use part of my CY 2018 tax refund. The fixed-rate on the bond at the time was set at 0.50%. Before that, it hadn’t been that high since November of 2008.

So I purposely overpaid taxes in CY18 to make sure I could score some paper bonds from my Uncle Sam come 2019. I already hear you cringing:

“Max, did you really give an interest-free loan to the federal government just to get a paper bond at a fixed 0.50% interest rate plus inflation?”

Yes, I did.

So how did I get them?  I basically answered the question as “Yes” when Turbo Tax asked if I wanted I bonds as part of my tax refund. I requested $1,000 worth. Behind the scenes, IRS Form 8888 was generated and requested the bonds. 

Since these bonds were issued in March 2019, the inflation rate adjustment will re-set to 0.0% in September and start paying a 1.56% composite rate.

Leave it to the Government

Max was surprised to find I was sent 8 separate I bonds all mailed in 8 separate envelopes with 8 separate postage fees. Okay, I suppose I was actually a little pumped to have a stack of government I bonds to show all my friends. If I would have read the fine print, it actually spells this out very clearly on the Treasury Direct website.

If you buy more than $250 of savings bonds, we will use $50 denominations to fill the first $250 and the fewest possible number of additional bonds for the remainder. For example, if you request $1,000 in paper I bonds, you will receive six $50 bonds, one $200 bond, and one $500 bond.

Treasury Direct Fine Print

I wonder who thought this one up?

Final Thoughts On I Bonds

Paper I bonds are a good way to tap into an extra $5,000 in inflation-protected bonds annually. In 2019, I purchased $10,000 in electronic I bonds and $1,000 in paper series I bonds. Unfortunately, the paper bonds are not FIREproof – no pun intended. Buy a safe.

Overall, I would say the process is a bit clunky and certainly not for a beginner in personal finance. You have to remember, Max considers this stuff a hobby so I am mostly just doing it to figure out how things work.

It also requires a short term loan to the government while you wait for the tax refund. Additionally, the Treasury Direct website could probably be simplified. I did not go this route in 2020 with my 2019 tax return, but I have bought several more electronically.

We will also eventually need to register these paper bonds with the Treasury Direct website to make sure that they are all accounted for. Until then, they will sit in my fireproof safe.

Do you own any I bonds?

This is not a recommendation to buy I bonds and only reflects my experiences.

Tags: I Bonds